Mortgage Watch

With interest rates low, Canadians are thinking about refinancing their mortgages. Here's how to tell if it's worth it.

Equity markets are see-sawing back and forth and yet there is an opportunity to build wealth in a low interest rate environment.

Where do interest rates touch most Canadians? Canadian mortgages. As rates have inched lower and lower, refinancing your existing mortgage becomes more and more appealing. Typically, the decision rests on the trade-off between how much it will cost to break out of the current mortgage and how much you would save in interest payments going forward.

Let us discuss an example where there is $100,000 outstanding on a locked-in fixed rate mortgage set up in January 2008 at six per cent for a five-year term. With 45 months still remaining on the term and posted rates for four-year fixed rate mortgages now at 4.4 per cent seems like a savings of 1.6 per cent!

However, to break the existing mortgage you would need to pay the greater of three months interest or the interest rate differential (IRD).

A back-of-the envelope calculation shows that three months interest would be $1,500, whereas the IRD would be $6,000. So the cost of breaking the mortgage would be $6,000. For arguments sake, let's assume you went ahead with this, and locked in for that four-year term at 4.4 per cent.

The interest saving over the next four years on $106,000 would be $5,176. That's less than what it cost to break the mortgage. It doesn't make sense in this scenario. It might make sense if you went from a 6 per cent fixed rate to a variable rate at prime + 0.8 per cent (Current 3.3 per cent). This time, you would be taking on the potential risk of an increase in interest rates over the course of the remaining four years.

What if you already have a variable rate mortgage? If you began the year with a $100,000 mortgage at Prime + 0.8 per cent and 25-year amortization, it would require payments of $517 each month over a five-year term. But then the Bank of Canada cut its benchmark lending rate by 50 basis points to 0.5 per cent - the lowest ever.

And the Bank of Canada has left itself open to further easing which means we could see the rate drop to 0.25 per cent on April 23. Those savings could get even bigger!

Alternately, you could use this saving to jump-start your Tax Free Savings Account or contribute into your RSP and link to a Systemic investment plan of balanced mutual funds.

There's another way to save on your mortgage payments. Simply increasing the frequency of your payments will reduce your interest payments over the life of the mortgage. You'll also be rid of it sooner.

Now compare the monthly payment to the weekly rapid payment. By converting your monthly payment to weekly rapid, you benefit from sneaking in an additional four weeks of mortgage payments each year. Over the life of the mortgage you'll shave four years of its life and keep more than $21,000 in your pocket.